UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
Securities Exchange Act of 1934
Release No. 38762 / June 24, 1997
Accounting and Auditing Enforcement
Release No. 926 / June 24, 1997
Administrative Proceeding
File No. 3-9337
In the Matter of
KENNETH F. RICHEY, CPA
ORDER INSTITUTING PROCEEDINGS AND OPINION AND ORDER PURSUANT TO RULE 102(e)
OF THE COMMISSION'S RULES OF PRACTICE
I.
The Securities and Exchange Commission ("Commission") deems it
appropriate and in the public interest to institute public administrative
proceedings against Kenneth F. Richey ("Richey"), a certified public
accountant, pursuant to Rule 102(e)(1)(ii) of the Commission's
Rules of Practice [17 C.F.R. 201.102(e)(1)(ii)].
In anticipation of the institution of these proceedings, Richey has
submitted an Offer of Settlement ("Offer"), which the Commission has
determined to accept. Solely for the purposes of these proceedings and any
other proceedings brought by or on behalf of the Commission or in which the
Commission is a party, and without admitting or denying any of the findings
herein except that he admits the Commission's jurisdiction over him and the
subject matter of these proceedings, Richey has consented to the issuance
of this Order Instituting Proceedings and Opinion and Order Pursuant to
Rule 102(e) of the Commission's Rules of Practice ("Order").
Accordingly, IT IS ORDERED that proceedings pursuant to Rule 102(e) of
Rule 102(e)(1) provides in relevant part:
The Commission may deny, temporarily or permanently,
the privilege of appearing or practicing before it in any
way to any person who is found by the Commission after
notice of and opportunity for hearing ... (ii) ... to
have engaged in improper professional conduct.
the Commission's Rules of Practice be, and hereby are, instituted.
II.
On the basis of this Opinion and Order, and the Offer, the Commission
makes the following findings :
BACKGROUND
A. Random Access, Inc. ("Random"), a Colorado corporation, was at
all relevant times in the business of designing, selling, installing,
supporting and servicing microcomputers throughout twelve states. In
September 1995, Random shareholders accepted a buyout offer from Entex,
Inc. ("Entex"), a privately-held New Jersey corporation. Random made its
first public stock offering in 1989. Under a Form S-2 registration
statement declared effective on August 11, 1993, Random made a second
public offering. At all relevant times, Random shares were listed on
Nasdaq.
B. Richey, age 41, is a certified public accountant and partner in
the Denver accounting firm of Williams, Richey & Co. ("WRC"). WRC was
Random's independent auditor from 1986 until 1993. Richey was the
concurring partner on WRC's audit of Random's 1992 financial statements, on
which WRC issued an unqualified opinion. Richey also provided additional
services to Random in connection with a special review and a public
offering that included the 1992 financial statements.
FACTS
C. Random's Co-op Claim Scheme
From 1991 through early 1993, Random generated a portion of its income
by filing inaccurate claims against certain cooperative advertising
accounts ("co-op accounts") administered by computer hardware and software
manufacturers with which Random did business. The purpose of the co-op
accounts was to reimburse computer resellers, such as Random, for costs the
resellers incurred in promoting the manufacturers' products. To obtain
payments from these co-op accounts, Random was required to submit to the
manufacturers a claim form, invoices reflecting its expenses, and other
proof that promotional expenses had been incurred. If a
particular manufacturer determined that Random's promotional expenses
qualified for reimbursement under its co-op program guidelines, Random
would be sent a check for the amount it had claimed.
The findings herein are solely for the purposes of this
proceeding and are not binding on any other person or entity
named as a respondent or defendant in this or any other
proceeding.
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In 1991, Random's employees began a practice of using the co-op
accounts to generate additional income by filing claims against the
accounts for expenses which Random could not document. To support these
claims, Random's employees created false invoices and falsified the
company's books and records.
The co-op claim scheme caused Random's income from continuing
operations to be misstated in financial statements contained in its annual
report on Form 10-K for the fiscal year ended August 31, 1992, which
misstatement was repeated in a Form S-2 registration statement declared
effective in August 1993 which incorporated the 1992 financial statements.
This misstatement of as much as $66,467 gave rise to a contingent liability
which required footnote disclosure in the respective financial statements
referred to above.
D. Richey's Retention
In April 1993, after the scheme had been discovered by Random's then-
controller, Random asked WRC to perform a special review of Random's
cooperative advertising program. Richey was the lead WRC partner involved
in the special review. At the beginning of the special review, Random's
controller informed Richey of his belief that Random's prior financial
statements may have been materially misstated and that Random's officers
may have known of the scheme. This conflicted with Random management's
assertions to Richey that the scheme was immaterial in amount and that they
had no knowledge of it until the controller discovered it. Despite this
red flag, on June 28, 1993, prior to the commencement of the special
review, Richey accepted Random management's position that the false claims
were immaterial and caused WRC to sign a consent to reissue the firm's
unqualified audit report on Random's 1992 financial statements for
inclusion in Random's 1993 registration statement.
To facilitate the special review, Random in July 1993 provided Richey
with schedules which company management stated reflected all claims it had
made against the co-op accounts during fiscal 1993. Random's management
also represented to Richey that no fraudulent co-op claims had been made in
fiscal 1992. In July, Richey and another WRC employee working under
Richey's direction began their review of Random's co-op claims. This
review soon revealed both that the schedules provided by Random were
inaccurate and incomplete, and that, contrary to the assertions of Random's
management, the company had in fact submitted fraudulent co-op claims
during fiscal 1992.
Despite these findings, while the special review was still incomplete,
Richey on August 2, 1993 signed a second consent to reissue WRC's
unqualified audit report on Random's 1992 financial statements for
inclusion in the first amendment to the registration statement. Further,
on August 13, 1993, Richey, on behalf of WRC, issued a comfort letter to
Random's underwriter. WRC did not issue its preliminary and final reports,
respectively, with respect to the special review until October and November
1993. Moreover, in performing the special review and procedures related
======END OF PAGE 3======
to the consents and comfort letter, Richey failed to conduct an independent
investigation into whether Random's management had knowledge of the co-op
claim scheme before it was brought to light by the company's controller.
Richey's issuance of the consents and the comfort letter were
premised, in part, on the assertion of Random's management that the scheme
would in any event be immaterial to Random's 1992 financial statements
because the company would be released from liability by the two
manufacturers with which Random had filed most of the false claims.
However, Richey performed no direct or independent verification procedures
as to the releases. In fact, the two manufacturers did not resolve the
issue with Random until October and November 1993, respectively.
E. Departure from GAAP
FASB No. 5, Accounting for Contingencies
Under Generally Accepted Accounting Principles ("GAAP"), Random was
required in its registration statement to disclose as a subsequent event to
its fiscal 1992 financial statements the contingent liability related to
the false claims it filed against the manufacturers. Absent such
disclosure, the financial statements were not prepared in conformity with
GAAP, contrary to WRC's representations in its audit report, comfort
letter, and consents.
Statement of Financial Accounting Standards No. 5, Accounting for
Contingencies ("FASB 5"), states that an estimated loss from a "loss
contingency" must be charged to income if it is "probable" that a liability
has been incurred and the amount of loss can be reasonably estimated. If
both conditions cannot be met, then the contingency should be disclosed
when there is at least a "reasonable possibility" that a loss has been
incurred. In such situations, "[t]he disclosure shall indicate the nature
of the contingency and shall give an estimate of the possible loss or range
of loss or state that such estimate cannot be made."
As of the date of Random's public offering, Random's two largest
suppliers had been notified that Random had overcharged them for co-op
claims, but had not yet committed themselves to release Random from
liability on the false claims. Therefore, Random was required to make
footnote disclosure of the contingent liability in the 1992 financial
statements in the registration statement. Such disclosure should have
included a description of the contingency and a range of possible loss.
Richey was the only WRC partner involved in the subsequent
events procedures relating to WRC's comfort letter and consents
to reissue its audit report for the 1992 financial statements
contained in Random's 1993 registration statement.
======END OF PAGE 4======
F. Departures from GAAS
1. Failure to Obtain Sufficient Competent Evidential Matter, Make
Reasonable Investigation, and Use Due Care in the Performance of
Work
AU Section 326, Evidential Matter, states that "[s]ufficient competent
evidential matter is to be obtained through inspection, observation,
inquiries, and confirmations to afford a reasonable basis for an opinion
regarding the financial statements under audit." AU Section 711, Filings
Under the Federal Securities Statutes, states in part that the auditor has
the burden of proving that he has made an investigation of subsequent
events occurring from the date of his audit report through the effective
date of a registration statement sufficient to uncover events that may
materially affect the financial statements included in the registration
statement. AU Section 711 defines reasonable investigation and reasonable
ground to believe as "that required of a prudent man in the management of
his own property."
Richey failed to obtain sufficient competent evidential matter and to
conduct a reasonable subsequent events investigation prior to his issuance
of WRC's comfort letter and consents. Richey issued those documents
knowing that WRC had not completed its special review of the co-op issue,
and that information had been brought to his attention concerning the
potential misstatement of Random's 1992 financial statements.
AU Section 230, Due Care in the Performance of Work, requires an
auditor to use due professional care in performing audits and issuing
reports. Richey also failed to meet this standard.
2. Failure to Evaluate Effect of Irregularities
Irregularities are defined in AU 316, The Auditor's Responsibility
to Detect and Report Errors and Irregularities, as follows: "The term
irregularities refers to intentional misstatements or omissions of amounts
or disclosures in financial statements. Irregularities include fraudulent
financial reporting undertaken to render financial statements misleading,
sometimes called management fraud, and misappropriation of assets,
sometimes called defalcations." The fraudulent co-op claims fit this
definition of an irregularity.
Richey was on notice of Random management's possible involvement in
the co-op scheme and thus of a possible irregularity. He nevertheless
failed to perform adequate procedures to determine whether Random's
management in fact had a role in it.
======END OF PAGE 5======
G. Conclusion
GAAS (AU Section 711) has long recognized that the auditor has an
important responsibility that extends beyond the date of the audit if the
audited financial statements are going to be used to sell securities to the
investing public. The diligent exercise of this responsibility is crucial
to the proper functioning of the market, and must be approached in a
serious and professional manner whenever the auditor is consenting to the
inclusion of a previous audit report in a registration statement or
offering comfort to underwriters or others in connection with the sale of
securities. The auditor must resolve issues that call into question the
validity of the previously-issued financial statements and audit report.
Richey failed to properly consider information that came to his attention
that should have caused him to seek additional evidence concerning the
veracity of the financial statements and the ability of his firm to reissue
its previous audit report and to give comfort to others.
FINDINGS
Based on the foregoing, the Commission finds that Richey engaged in
improper professional conduct within the meaning of Rule 102(e)(1)(ii) of
the Commission's Rules of Practice with respect to the comfort letter and
consents issued in connection with Random's 1993 Form S-2 registration
statement and amendment thereto.
III.
ORDER
Based on the foregoing, the Commission finds it appropriate and in the
public interest to accept the Offer of Richey and impose the sanctions
consented to therein.
Accordingly, IT IS HEREBY ORDERED, effective immediately, that:
1. Richey is suspended from appearing or practicing before the
Commission as an accountant for a period of nine months;
2. Nine months from the date of this Order, Richey may resume
appearing or practicing before the Commission as an independent accountant
provided that:
(a) Richey or any firm with which he is or becomes associated in
any capacity, is and will remain a member of the SEC
Practice Section of the American Institute of Certified
Public Accountants Division for CPA Firms ("SEC Practice
Section") as long as he appears or practices before the
Commission as an independent accountant;
(b) Richey complies with all applicable SEC Practice Section
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requirements, including all requirements for periodic peer
reviews, concurring partner reviews, and continuing
professional education, as long as he appears or practices
before the Commission as an independent accountant.
By the Commission.
Jonathan G. Katz
Secretary
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